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ONB earnings call for the period ending December 31, 2018.

Contents:

Prepared Remarks

Questions and Answers

Call Participants

Prepared Remarks:

Operator

Welcome to the Old National Bancorp First Quarter 2019 Earnings Conference Call. This call is being recorded and has been made accessible to the public in accordance with the SEC Regulation FD. Corresponding presentation slides can be found on the Investor Relations page at oldnational.com and will be archived there for 12 months.

Before turning the call over to management. I would like to remind everyone that as noted on Slide 2, certain statements on today's call may be forward-looking in nature and are subject to certain risks, uncertainties and other factors that could cause actual results to differ from those discussed. The Company's risk factors are fully disclosed and discussed within its SEC filing.

In addition, certain slides contain non-GAAP measures, which management believes provide more appropriate comparison. These non-GAAP measures are intended to assist investors understanding of performance trends. Reconciliations for these numbers are contained within the appendix of the presentation.

I would now like to turn the call over to Bob Jones for opening remarks. Mr. Jones?

Robert G. Jones -- Chairman and Chief Executive Officer

Great. Thank you, Carmen and good morning, everyone and thank you for joining us this morning. I know that many or probably in fact all of you were hoping that you would not hear from me again, but given that my last day as CEO is May 2nd, we thought there would be value in giving you an update on our transition. In short, it is going extraordinarily well. Jim and I have obviously had a great relationship for many years and that relationship has gotten even stronger over the last few months. We have spent a great deal of time on transitional topics, meeting with clients and spending joint time with associates.

Change is good and in fact, it is very good, and I've seen a genuine excitement and increase in energy around the Company, as we have jointly made the rounds. I'm extraordinarily excited for the future of our Company and extraordinarily proud of Jim and his leadership team. I have pledged to him that I'll always be available for him, if the need ever arises.

Good morning. Thank you, Bob. Your insights and humor on these calls are going to be missed for sure.

I would characterize our first quarter results as consistent with our stated strategy and in line with our expectations. Net income was a record $56.3 million and earnings per share were $0.32. When adjusted for merger charges, earnings per share were $0.33. Total loans were down slightly due to lower line utilization, seasonally lower production and continued elevated levels of commercial client selling their businesses. I'm confident, we aren't losing clients or opportunities because we are competitive. In fact, our markets remain strong and our clients continue to be optimistic. As a result, our commercial pipeline built nicely over the quarter and now stands at a record high. More importantly, the accepted loan category in our pipeline is up 49% quarter-over-quarter and has continued to build nicely in April. This should provide a good tailwind, as we move into the second quarter. However given the global backdrop and inconsistent economic data, we are also staying disciplined and continue to focus on lending in our footprint and not buying commercial credit. We do not believe this is the right time to stretch on credits and pricing.

Total deposits increased during the quarter and our beta remains a strong 18% cycle to-date. Loans to deposits also a low 84%. I remain focused on improving our operating leverage, which improved by almost 500 basis points year-over-year and our adjusted efficiency ratio was below 60%. In the first quarter, we announced that the Board authorized the share repurchase plan for up to 7 million shares. We would've been perfectly happy to not execute the plan, but industry price volatility during the quarter allowed us a window to repurchase 1.5 million shares at an average price of approximately $16.45. Despite these repurchases, tangible book value per share grew by almost 5% and tangible common equity to assets was up 19 basis points to 8.66%.

The conversion from our former KleinBank systems and branches took place a week ago. The conversion went incredibly well with minimal client disruption. It's important to note that cost savings from the former KleinBank are already starting to be realized, and we remain on track for 40% annualized savings fully realized in the back half of the year.

A quick update on M&A. Our strategy hasn't changed. We remain an active looker and a selective buyer. However, my desire would be to spend 2019 more inwardly focused working to improve the associate and client experiences and execution. Having said that scale was still very important. Technology investments and regulatory burdens are still very high. I've told the Board and our associates that we will remain patient and wait for the perfect pitch. Much like Bob and I have been working through our transition, I've been working with Brendon on a smooth hand off to the (ph) CFO duties. I'm confident, you'll quickly see why Brendon was the absolute right choice, as our next CFO.

With that introduction I'll now turn the call over to Brendon.

Brendon Falconer -- Chief Financial Officer

Thank you, Jim. Turning to the quarter on Slide 4, GAAP earnings per share were $0.32 and our adjusted earnings per share were $0.33. Adjusted earnings per share excludes $1.2 million in merger-related charges, as well as debt securities losses.

Slide 6 shows the trend in average outstanding loans, which benefited from a full quarter of the Klein partnership. The quarter-over-quarter change in end of period loans was primarily driven by declines in the C&I and indirect portfolios. The decline in commercial outstandings was influenced by seasonal factors, lower line utilization and elevated levels of prepays due to business sales. As Jim referenced, our period end pipeline is the highest in the Company's history. Moreover, the current pipeline shows an increase of 49% over prior quarter in the accepted category, which has historically carried a higher pull through rate. We are encouraged by both the level and more importantly, the quality of our pipeline and feel that we are entering the second quarter with positive momentum.

Slide 7 shows our year-over-year change in earning assets. We continue to show progress in our ongoing effort to deliver more optimal earning asset mix with a focus on commercial loans. Excess liquidity generated this quarter resulted in a higher percentage of securities compared to last quarter with new money yields of 3.69% compared with a portfolio yield of 3.03%. That noted, we have continued to remix the balance sheet toward more productive commercial and commercial real estate loans and out of indirect and other loans.

Moving to Slide 8, our demonstrated ability to maintain a stable low cost, core funding base in this challenging pricing environment is a clear competitive advantage and is a testament to both the quality of our banking franchise and the strength of the relationships we have built with our clients. Our deposit beta is now 18% current cycle to-date with the total cost of deposits of only 46 basis points. A disciplined approach to deposit pricing will remain a key focus, as we navigate the remainder of this rate cycle.

Next on Slide 9, you'll see the detailed changes in our first quarter net interest income and corresponding margin. Net interest margin excluding accretion was 3.3%, a full quarter of positive impact from our recent Klein partnership was offset by fewer days, earning assets mix change and lower interest on nonaccruals. Accretion decreased 6 basis points from the fourth quarter and is now less than 5% of total revenue.

Slide 10 show trends in adjusted noninterest income. Both mortgage banking and capital markets showed nice revenue growth over the prior quarter, while other fee categories remained relatively stable. We ended the quarter with the largest mortgage pipeline in recent years and strong momentum in this line of business heading into the second quarter. Also, included in the slide is our purchase versus refi percentage for the mortgage business. Purchases accounted for 77% of our first quarter volume with only a modest increase in refi activity,

Next, Slide 11 shows the trend in adjusted noninterest expenses. The first quarter included an additional month of the Klein partnership, as well as a seasonal uptick in payroll related taxes and benefits. We are pleased with our continued ability to control expenses and remain on track for the anticipated cost savings from our Klein partnership in the back half of 2019. Our adjusted efficiency ratio for the first quarter was 59.51%, a 299 basis point improvement from the first quarter of 2018. As Jim said, expense control is an important part of our culture, and we remain committed to generating positive operating leverage.

Slide 12 has our credit metrics. Credit conditions remained benign with non-performing and under performing loans near cycle lows. We recorded $1 million in provision expense during the first quarter, while posting net charge-offs at $0.9 million. The 63 basis points of reserves against organic loans and 340 basis points in loan marked against the acquired loans, we believe that we have adequate reserve coverage.

Before we turn away from credit, we wanted to provide a brief update on CECL. Progress toward complying with the new standard is on schedule with all credit models both built and validated. Second quarter activities will be concentrated on running sensitivity analysis and finalizing assumptions. We anticipate providing an estimated range of the day one impact in the third quarter.

Slide 13 provide some key takeaways from our first quarter performance. We are pleased with our results driven by good execution against our strategic objectives. We maintained our strong low-cost deposit base with a low 18% deposit beta through the cycle. We continue to have a disciplined approach to credit risk management resulting in net charge-offs of just 3 basis points. While loan growth was lower than our expectations, we ended the quarter with the highest pipeline in the Company's history, and we remain optimistic about our ability to produce quality loans without compromising on the credit discipline that has served us well in prior cycles. Lastly, we are driving positive operating leverage, improving our efficiency ratio and increasing profitability metrics.

Slide 14 includes our outlook for 2019 and 1Q, '19 starting points. We expect commercial loan production to increase based on both the size and quality of our pipeline. Commercial activity will skew toward C&I versus CRE. We have ample capacity for both asset classes.

Net interest margin excluding accretion is expected to continue benefiting from low-cost deposits and improving asset yields, but the shape of the current yield curve presents challenges. Given the markets view of the path of short term interest rates, we have gradually positioned our balance sheet to a more neutral footing to increase protection against the potential of downward rate shocks. As the slide suggests, fees and expenses should follow normal seasonal patterns, and we remain very focused on continuing to drive positive operating leverage. Our full year tax rate is expected to be approximately 24% on a FTE basis and approximately 21% on a GAAP basis. We continue to expect tax credit amortization to be de minimis in 2019. Lastly, we remain very optimistic about our opportunities in Minnesota. We recently completed our conversion of Klein's, and our cost saves remain on track.

With that we're happy to answer any questions that you may have. And we do have the rest of the team with -- here with us including, Jim Sandgren, and Daryl Moore.

Questions and Answers:

Operator

(Operator Instructions) Your first question comes from the line of Scott Siefers with Sandler O'Neill.

Scott Siefers -- Sandler O'Neill -- Analyst

Good morning, guys.

Robert G. Jones -- Chairman and Chief Executive Officer

Good morning, Scott.

Scott Siefers -- Sandler O'Neill -- Analyst

Hey, I guess, just quick question on expenses first. I think at least relative to what I anticipated the -- the first quarter run rate when you exclude the merger-related charges came in a little better than I had anticipated. I guess, as though -- was sort of thinking about things, I figured something in sort of the mid 120s might have been a better approximation for kind of the first half of the year and then a step down in the second half, as the cost savings from Klein were achieved. Can you just sort of provide an update on sort of how you see, you know, ideally the second quarter core trend looking and then if that step down for the full year, you know, sort of still holds true.

Brendon Falconer -- Chief Financial Officer

Well, you know, seasonally expenses are always higher in the first half of the year, you're right with that. I would just say that you know, I don't -- the first quarter is a pretty normal. We have the merit increases, which affect our run rate starting April, and we are starting to realize some of the savings from Klein already, as we said in my prepared comments and fully expect them to hit in the second half of the year. So I don't think that we are far off. First quarter is pretty typical and with a little bump for merit increases heading into the second quarter here.

Scott Siefers -- Sandler O'Neill -- Analyst

Okay. All right. Perfect. And then it sounds like you guys are still quite optimistic on the production side of things, but the overall net growth continues, it sounds like to get -- get impacted by those pay downs that have been sort of nagging for the past few quarters. Is there any sense that -- that's abating? And how -- how do you expect the average net growth to trend from here on now?

James A. Sandgren -- President and Chief Operating Officer

Yes. This is Jim Sandgren. Yeah, we're -- we're very optimistic, as we -- as we roll into the -- to the second quarter, as both Jim and Brendon alluded to. You know, we have continued to suffer from some elevated payoffs again that happened in the first quarter with some large sales of companies, so that -- that continues. But as we look at the pipeline growing to $2 billion and maybe even more importantly, our accepted category being the highest level typically those pull throughs are 90% or higher. So we really feel good about that.

The other piece of the pipeline that I think is encouraging is that it's a higher percentage of C&I, and in the first quarter, we did have more C&I production than we had in CRE, so that -- that also feels pretty good to us. Also, we still have about almost $550 million in construction advances on some of our commercial construction projects that obviously didn't get advanced on much in the first quarter due to some pretty -- pretty tough weather in a lot of our markets.

Brendon Falconer -- Chief Financial Officer

And Scott, our -- our line utilization was down almost 3%, so then it really helped outstandings.

Hey good morning, everybody. Jim, I think in your prepared remarks you talked about buybacks given the opportunity with the stock. Given your comments on loan growth and more optimism is what we're hearing I think, should we be assuming that you take the foot off a little bit on the buyback at least for the near term? Or is this kind of a fair level since capital levels actually still grew in the quarter?

Yeah. I think we're being opportunistic. When we have volatility like we saw at the end of last year and really in March, I guess of this year, we're going to be opportunistic and step into it. And I think despite balance sheet growth, we have capacity because our capital levels, we are completely fine with. So we always (ph) be opportunistic.

Chris McGratty -- KBW -- Analyst

Okay. And on the core margin, the betas -- the deposit betas remain pretty low compared to peers. How should we be thinking Brendon, maybe the next few quarters on core NIM trajectory given where we are with the curve and rate expectation shifting? Thanks.

Brendon Falconer -- Chief Financial Officer

Sure. I -- I think with -- with earning asset mix, should continue in Peru with the commercial loan production, so that will be certainly a benefit to margin. I pointed to our new business rates on both investments and loans exceed the portfolio yields, so that should be a positive. And then the big question mark is where deposits go from here? But we generally feel -- feel good about the trajectory of the -- the earning asset side.

Chris McGratty -- KBW -- Analyst

Okay. So -- so margins potentially finding support was not maybe increasing a little bit after the compression this quarter? Or stability kind of the message?

Yeah. Obviously, this rate environment -- the belly part of that curve just been really, really tough in the first quarter, and so we've got a little bit of relief here. But -- but we're hoping for a better rate environment going forward.

Chris McGratty -- KBW -- Analyst

Got it. Great. Thank you.

Operator

Your next question comes from the line of Nathan Race with Piper Jaffray.

Robert G. Jones -- Chairman and Chief Executive Officer

Good morning, Nathan.

Nathan Race -- Piper Jaffray -- Analyst

Hey, guys. Good morning. Maybe I want to start on credit with Darryl. The criticized loans are up fairly noticeably in the quarter, I think up 10% on a absolute basis. So just any color on what you're seeing there? And perhaps an update on the healthcare credit that percolated (ph) toward the back half of last year as well?

Yeah, sure. The increase in this special mentioned and a little bit in the substandard really relate probably -- really relate to our commercial real estate portfolio. We talked over the past three or four quarters about how we're tightening that up. We don't see anything significantly in that portfolio. What we are seeing is just a slight increase in vacancy rates on some of the projects, as well as some concessions. And so for those that are behind what we projected when we approved those construction loans or those loans, we split those into that special mentioned category until they begin to stabilize and that vacancy ticks up a little bit.

With respect to that one credit lapse in the fourth quarter, the healthcare credit actually that stabilized. We had some additional equity that was put in the project by one of the significant owners and that's beginning to lease up the management companies. So we're feeling better about that credit today.

Nathan Race -- Piper Jaffray -- Analyst

Got it. That's helpful. And perhaps a follow-up, in terms of that lack of -- lack of absorption, is that in any particular geography or market or asset classes?

Brendon Falconer -- Chief Financial Officer

What we're seeing at this point and time, I would say, it's across the asset classes. But if you had to have me pick one, I would say it's in the multifamily at least in our portfolio and we have a concentration in markets. There's no particular market that is worse than the other. We've generated more loans in some of the markets, so there is no market dynamic working there other than just the fact that we've got more multifamily loans in some of our markets than others.

Nathan Race -- Piper Jaffray -- Analyst

Got it. Understood. And if I could just ask one more on line utilization. It looks like it ticked down 200 basis points compared to the fourth quarter. Is that just seasonal or is there anything else there?

Brendon Falconer -- Chief Financial Officer

Nat, we've been running -- it's seasonal little bit, but this was a bigger drop than we had seen, and -- and I think that impacted balances by close to $65 million. We would anticipate that utilization bouncing back up in the second quarter. So little (multiple speakers) deal.

Nathan Race -- Piper Jaffray -- Analyst

Understood. I appreciate the color guys. Thank you.

Operator

Your next question comes from the line of Terry McEvoy with Stephens.

Robert G. Jones -- Chairman and Chief Executive Officer

Good morning, Terry.

Terry McEvoy -- Stephens -- Analyst

Hi, good morning. The betas remain really low. So I guess my question is, where do you see more future upward pressure on deposit costs. Would it be in your legacy community markets or some of your newer more metropolitan markets?

Brendon Falconer -- Chief Financial Officer

This is Brendon, Terry. Yeah, I think the pressure is really coming from some of the -- some of the newer markets. Legacy markets remain really low. The exception pricing request we get over legacy markets are -- are relatively lower compared to our newer markets, but -- but the competition is tough and -- and acquisition rates continue to be -- to be high. But again, I'd say that we'll weather that storm better -- better than most. So but hoping that -- hoping that deposit pricing moderate from here, but we have not seen a major change in our clients expectations for rates. Yeah.

James A. Sandgren -- President and Chief Operating Officer

Terry, you can imagine, we have a lot of discipline around this process, a lot of conversation and make sure that we're absolutely only repricing deposits we need to reprice, and -- and it's been a good healthy process for us here at the Company.

Terry McEvoy -- Stephens -- Analyst

And then Jim, follow-up for you. You mentioned in the prepared remarks, your inward focus, but if you see that perfect pitch you're going to swing the bat. Could you just talk about that perfect pitch in terms of size, markets, characteristics to help us understand now that you're up to -- up to bat, what you're looking for?

Great -- great question. And it really hasn't changed at all, as you know that Bob and I've been batting -- batting to our side for a long, long time here. And so for us, I think it's a bank between $1 billion and $3 billion (ph) that's in market that really adds to a market, where we don't have as much skills, we'd like to be that we can make sure that we get good cost saves out of. So it's pretty much what we've been looking for in the past, right. In our footprint that adds a scale to an important market for us, where we subscale today and that we can rely on cost saves versus revenue growth.

Terry McEvoy -- Stephens -- Analyst

Thanks. And then just the last one. I'm not quite sure what to make here, Klein client added $35 million of loan production in the first quarter, which -- as an analyst, I can just calculate 8% of the quarterly production. Why is that bullet point there? I'm guessing it was better than expected and there's momentum within -- within that market?

Brendon Falconer -- Chief Financial Officer

Yeah. We -- we definitely have a lot of momentum in that market. Now, the conversion is behind us, a really strong commercial team that's added to our legacy Old National team up in Minnesota. So feel good about the growth opportunities for us in -- in that market.

We couldn't be more pleased with the team that we have in place both in the commercial and the retail side. And as we said earlier in our prepared comments that conversion has gone incredibly well.

Terry McEvoy -- Stephens -- Analyst

Great. Thanks, everyone.

Operator

Your next questions comes from the line of Scott Beury with Boenning & Scattergood.

Robert G. Jones -- Chairman and Chief Executive Officer

Hi, Scott. How are you?

Scott Beury -- Boenning & Scattergood -- Analyst

Hi, good morning. Just, first question, I guess is a follow up. In terms of the pipeline, do you have any -- any color, you could give us in terms of how that's spread out geographically?

Brendon Falconer -- Chief Financial Officer

Yeah, sure. Right now, a big chunk of that is in our Wisconsin, Minnesota, Michigan markets. We continue to have strong production and pipeline growth out of our Louisville, Kentucky market as well. And then certainly pockets of our Indiana markets, but really led by Wisconsin, Minnesota, Michigan right now.

Scott Beury -- Boenning & Scattergood -- Analyst

Okay. So the vast majority is or maybe not the vast majority, but the bulk of it is really coming out of some of the newer markets?

Brendon Falconer -- Chief Financial Officer

The largest piece, but we still have good pipelines in our legacy markets as well.

Scott Beury -- Boenning & Scattergood -- Analyst

Okay. That's helpful. And then on the earning asset mix, obviously loan demand, loan balances were a little more challenging this quarter, given some of the pay downs and some of the seasonal factors. But I noticed that you did have an increase in the securities, in the earning asset mix as well as at period end. And I was just curious, if you could kind of talk about that and give your expectations on whether that's going to kind of moderate, as you see some of these loans come through?

Brendon Falconer -- Chief Financial Officer

Sure. Yeah. So as -- as loan growth was a little softer in the first quarter, deposits were up. We had some excess liquidity. We put it to work in the investment portfolio. And as loans increase, we intend to improve that earning asset mix and we'll exceed that (ph) portfolio as needed.

And your next question comes from the line of Jon Arfstrom with RBC Capital Markets.

Robert G. Jones -- Chairman and Chief Executive Officer

Good morning, Jon. How are you?

Jon Arfstrom -- RBC Capital Markets -- Analyst

Hey, good. Good morning to all of you. Just a couple of smaller ones, I think you know most of the big topics have been picked over, but can you touch on the capital markets driver. This quarter, it was kind of a bigger item than -- than I had expected, and that well -- go to that one first just what's happened there (ph)?

Robert G. Jones -- Chairman and Chief Executive Officer

Yeah. Just real quick, I mean, you know it was a strong quarter, mostly I think on existing floating rate loans being swapped to fixed and so it -- there is ebbs and flows, but it's a nice business to have -- nice business to be in and it really gives our client a lot of option to protect them from rate risk, but mostly driven (ph) opportunistically when rates kind of fell here in the -- in the quarter.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Okay. So not -- not one big item in there?

Brendon Falconer -- Chief Financial Officer

No, but we continue to see good momentum going into the second quarter with that business as well.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Okay. The other one is mortgage. You talked about record pipelines and obviously it was a decent quarter this quarter, but what -- what's possible there over the next couple of quarters?

Brendon Falconer -- Chief Financial Officer

Well you know, Chris very well Jon and he's pretty giddy about the business. So we feel really good about heading into -- to the quarter here with the pipeline continue to grow and really seeing nice opportunities out in Minnesota as well, which I think speaks a lot to both the former Anchor franchise and former Klein had good mortgage businesses, but together we're better. And so I think the opportunities will continue to present themselves in Minnesota. And I think we will have some decent quarters going forward based on what I'm seeing in the pipeline so far.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Okay. And then I guess, the last one back to deposit pricing, I always talked about that quite a little bit, but you had a pretty big step up in checking and money market costs. Is that would you call that Klein related or is you're just playing defense there? What -- what was the driver the -- the big increase in those two?

Brendon Falconer -- Chief Financial Officer

Yeah, Jon, this is Brendon. No, not competition. We have been running some targeted money market specials in select markets, where we have relatively low share and that's been driving some of the growth and some of the increase in pricing in that -- in that line item.

Robert G. Jones -- Chairman and Chief Executive Officer

So I think I would characterize it as a partly defensive and partly offensive. We're really trying to get new money in the door and the new money cost is obviously higher than we have on our existing books, but it's really trying to be as much offensive as anything else.

Well, thanks everybody for their attendance. And as I said in my opening remarks, we're certainly going to miss Bob on this call, and I don't have nearly the sense of humor that he has and the -- and the analogies, but thank you all for your participation. And as always, we'll be around for follow-ups.

Operator

This does conclude Old National's call. Once again, a replay along with the presentation slides will be available for 12 months on the Investor Relations page of Old National's website, oldnational.com. A replay of the call will also be available by dialing 1-855-859-2056. The conference ID 2358708. This replay will be available through May the 6th. If anyone has additional questions, please contact Lynell Walton at 812-464-1366. Thank you again for your participation in today's call.

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